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This chapter first characterizes Pareto‐efficient allocation of risk within a community. A discussion of the documented existence of ex post insurance mechanisms within communities in less developed countries, and of quantitative studies of community‐level risk‐sharing follows. Next, the theory, including the permanent income hypothesis, and the empirics of consumption‐smoothing over time through savings and credit are studied. The two complementary mechanisms of consumption‐smoothing over time and full cross‐sectional insurance are then compared, followed by the result that if either...

This chapter first characterizes Pareto‐efficient allocation of risk within a community. A discussion of the documented existence of ex post insurance mechanisms within communities in less developed countries, and of quantitative studies of community‐level risk‐sharing follows. Next, the theory, including the permanent income hypothesis, and the empirics of consumption‐smoothing over time through savings and credit are studied. The two complementary mechanisms of consumption‐smoothing over time and full cross‐sectional insurance are then compared, followed by the result that if either mechanism exists and is efficient, household production is separable from preferences. In the absence of an ex post insurance mechanism, households may employ ex ante strategies of reducing income fluctuation such as choosing conservative production activities.